Liquidation Values and Debt Capacity: A Market Equilibrium Approach




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    • From Harvard University and The University of Chicago, respectively. We are grateful to Douglas Diamond, Eugene Fama, Robert Gertner, Milton Harris, Glenn Hubbard, Steven Kaplan, Robert McDonald, Merton Miller, Raghuram Rajan, Artur Raviv, Howard Zimmerman, and especially to Harry DeAngelo and René Stulz, for helpful comments. We are also grateful to the National Science Foundation, Bradley and Sloan Foundations, and Dimensional Fund Advisors for financial support.


We explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets. When a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage. We use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle, as well as the rise in U.S. corporate leverage in the 1980s.